Are you looking for a way to hedge macro exposure and/or a creative way of expressing a bullish view ahead of possible event risk tied to French elections and a geopolitical environment littered with land mines?
Well, of course you are. And do you know who’s got your back? Goldman – or, as we like to call the bank, “a bunch of people who definitely aren’t telling you this so they can take the other side of the trade.”
On Monday morning, the squid’s options research team is out noting that lackadaisical credit markets have outperformed equity on a risk-adjusted basis (“no matter how you slice it”) over the past month (i.e. you’d have done better selling protection than buying the equity) and if history is any guide, that means you may want to consider some relative value trades. Find more below.
Significant credit outperformance, no matter how you slice it. Credit has significantly outperformed equity over the past month on a risk-adjusted basis. More specifically, CDX IG 5Y has outperformed its corresponding equities by 1.8, 1.0, 1.3 and 2.0 standard deviations over the past 1, 2, 3 and 4 months, respectively. We see this as an attractive entry point for relative value trades. For investors looking for a macro hedge, credit offers more attractive hedging opportunities. For investors adding to bullish positions, equity offers more attractive buying opportunities.
How big is the short-term opportunity? History as a guide. We look back over the past 7 years at each time credit and equity have diverged by more than 1 standard deviation over a 1, 2 and 3-month rolling period. Divergences of this magnitude have occurred 10 times and lasted an average of 8 days. Over the subsequent 1 month, the lagging asset outperformed the leading asset by 2.5% with a standard deviation of 3.5%. Our study shows the “diverging asset” (the asset that drove the divergence) was responsible for 2/3rds of the convergence profit. This suggests that in the current divergence, hedging with credit may have a higher profit potential than long equity over the next month.